Credit Q&A: Build Credit, Dispute Errors, and Prioritize Debt

Laura answers questions about how to build credit, manage credit utilization, correct credit errors, handle past due accounts, and prioritize debt the best way possible. Read or listen to the audio podcast for key tips to maintain good credit for life.

Qualifying for a 30-year mortgage that charges 1% less because you have good instead of average credit could save you $30,000 on a $150,000 loan. The bigger your loan the more potential interest savings is at stake.

But even if you decide to never borrow a penny, your credit rating still affects your finances. For instance, having poor credit means you could be turned down by a prospective employer or have an application to rent an apartment denied.

Poor credit typically causes you to pay more for security deposits on different kinds of utility accounts, such as power, cable, and a cell phone. Your credit is also a big factor in the rates you pay for auto insurance, homeowners insurance, and renters insurance, in most states.

For all these reasons, maintaining good credit is a fundamental part of a healthy financial life. In this post, I’ll answer four questions about how to build credit, correct credit errors, handle past due accounts, and prioritize debts the best way possible.

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4 Questions & Answers About Credit

Credit Question #1

Thomas M. says, “I have four credit cards, two of which have apoplexy-inducing balances with high utilization ratios—but I plan to pay them off within about five months. My other two cards are paid off in full every month and have low utilization rates. When will I see the high utilization matter less for my credit scores?”

Answer:

Thomas, thanks for your question and for being a long-time participant in the Money Girl community! If you’re not sure what the heck Thomas is talking about, stay with me. I’ll answer his question and then give you more background on this topic.

Your credit utilization on revolving accounts, such as credit cards and lines of credit, is graded or scored every month as your creditors report new information to your file and the reporting agencies update your balance information.

So, if your available credit limit stays constant while you reduce your outstanding balance each month, your utilization ratio will also decrease each month. That boosts your credit scores right away and they’ll continue to rise each month as you chip away balances and cut your utilization rate.

Now, let me back up and make sure you understand credit utilization. Your credit utilization ratio is a formula that divides your outstanding balance on a revolving account—like a credit card or a line of credit—by your credit limit on the account. For example, if you currently owe $1,000 on a credit card that has a $2,000 credit limit, your ratio is $1,000 divided by $2,000, or 50%.

To build or maintain great credit, the lower your credit utilization ratio the better. A low credit utilization ratio tells potential lenders and merchants that you’re using credit responsibly. A high ratio indicates that you could be under financial strain or be getting close to missing a payment.

A low credit utilization ratio tells potential lenders and merchants that you’re using credit responsibly. A high ratio indicates that you could be under financial strain or be getting close to missing a payment.

Optimal credit utilization is no more than 20% to 25%. That means for a card with a $2,000 credit limit, your ideal balance would never exceed $500. But what if you want more spending power?

If you need to charge more than 25% of a credit card’s limit, it’s time to get an additional credit card so you can spread out the charges. It’s better for your credit to have two cards, each with low utilization rates, than to have one card that you consistently max out.

A common misconception about credit utilization is that you can exceed the recommended 25% limit without hurting your credit, as long as you pay off the balance in full each month. Paying off your entire credit card balance each month is a wise move because you never accrue interest.

Problem is, using too much of your available credit can still be a drag on your credit scores, even when you pay it off each month. The reporting dates used by card companies varies and typically is not the same as your statement due date.

In other words, if your balance is high on the date your card company reports it, you’ll have a high utilization ratio and see your scores go down, even if you pay off the entire balance the next day. So, it’s always better to have low balances on multiple credit cards than to have one card that you max out.

If you don’t want more than one credit card, another strategy is to make multiple payments throughout the month, such as one per week, to reduce the balance as much as possible before it’s reported to the nationwide credit bureaus.

To build credit, you don’t have to pay interest or go into debt. You can use a credit card to make small charges that you pay off in full every month. Again, interest only accrues when you carry over a balance from month to month.

Also note that your utilization ratio is generally considered a comparison of your total credit used compared to your total credit available. However, it’s also calculated on a per-card basis, so don’t let your balance on any one card get too high.

To build credit, you don’t have to pay interest or go into debt. You can use a credit card to make small charges that you pay off in full every month. Interest only accrues when you carry over a balance from month to month.